The European taxonomy is changing in order to cover a wider range of economic activities with favourable environmental impacts. This should provide investors with greater transparency and clarity and guarantee the alignment of market practices in the entire EU.

The European Union taxonomy was created in order to steer capital flows in favour of sustainable economic activities. Its principal objective is to supply a robust and transparent framework in terms of the definition of activities that make substantial contributions to the resolution of the climate and environmental crisis. The six objectives of the taxonomy are:

Climate change mitigation
Climate change adaptation
The sustainable use and protection of water and marine resources
The transition to a circular economy
Pollution prevention and control
The protection and restoration of ecosystems and biodiversity

A regulatory framework for the taxonomy now expanded to include six objectives

The methodology initially addressed the first two objectives (climate change mitigation and adaption) and limited itself to narrow range of activities viewed as eligible, ineligible or not covered by the taxonomy (chart 1, left). It is nevertheless necessary that the framework of the taxonomy address all six environmental objectives and all segments of the economy in order to respond to the need for an urgent transition. The new expanded framework addresses four other objectives and classifies activities based on their performance levels, introducing two new thresholds for measuring environmental impacts (chart 1, right).

The activities that exceed the “do no significant harm” threshold are listed in red. These activities involve nonsustainable performances requiring an urgent transition in order to avoid significant harm or significantly harmful performances requiring an urgent halt. The intermediate performances between the two thresholds are listed in yellow. The “substantially contribute” threshold continues to define the green classification, covering activities that contribute to the climate transition (previously defined as aligned with the taxonomy).

Chart 1: Change in the European taxonomy methodology

Source: European Commission - The Extended Environmental Taxonomy Final Report

If we take the example of the production of electricity using natural gas, direct emissions from natural gas-fired power plants average between 350-500gCO2e/kWh, far above the “do no significant harm” threshold set at 270 gCO2e/kWh (chart 2). Their performances are therefore classified in the red zone. In order to be eligible for the green taxonomy, the installations should have emissions below 100 gCO2e/kWh. Another important point in the taxonomy is the dynamic nature of eligibility criteria. While the “do no significant harm” threshold is currently set at 270 gCO2e/kWh for natural gas-fired power stations, this threshold will fall to 100 gCO2e/kWh in 2030. The threshold for green eligibility will fall from the current 100 gCO2e/kWh to 0 gCO2e/kWh in 2050.

Chart 2: Eligibility thresholds for natural gas-fired power stations in the European taxonomy

Source: European Commission - The Extended Environmental Taxonomy Final Report

Which sectors are the most concerned and what impact on investments in the transition?

The expanded methodology can be applied to a broad range of activities with specific criteria beyond that of CO2, such as the amount of recycled waste or the reduction in the use of water in industrial processes. It is nevertheless important to note that certain activities by their nature have little environmental impacts (positive or negative), notably service companies. As such, we estimate that the priority economic activities can be divided between the following sectors:

Agriculture, forestry and fishing
Mining activities
Industrial production and manufacturing
Energy
Construction and buildings
Information and telecommunication technologies
Transportation
Environmental restoration
Water supply, sewage treatment, waste management

An expanded taxonomy with a more nuanced approach to the recognition of activities with different levels of performance will be useful in guaranteeing that investments be labelled in a clear and transparent manner. The new framework will enable investors to better accompany companies in their green transition trajectories and enhance the transparency of their exposure to activities requiring urgent transition or abandonment. Our fund management team welcomes these changes in the taxonomy and, in the framework of the management of the Mandarine Global Transition fund, again notes that its investment process corresponds to the six major environmental objectives of the taxonomy and targets activities classified as green with a significant contribution to the energy and ecological transition.

Sources:
The Extended Environmental Taxonomy: Final Report on Taxonomy extension options supporting a sustainable transition [March 2022]
Citi Global ESG & SRI: The Six EU Taxonomy Objectives – Which Stocks Screen Well? [April 2022]

The European environmental taxonomy is being expanded

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